Wage-Price Guidelines; R. Higgs

WAGE-PRICE GUIDELINES: Robert Higgs "f:,;VAGE and price controls in a market economy are, according to Shultz and Dam, like an organism: they pass inevitably, and quickly, through a "life cycle."! Perhaps a more instruc tive analogy is the military diver sionary tactic that sends a platoon to mount a surprise attack on the :flank of an advancing enemy divi sion. This preposterous little counter offensive may throw the enemy into momentary confusion, force him to divert men and equipment to other sectors, even compel him to with draw temporarily from certain oc cupied territories. But none of this can last. Unless a genuinely power ful force is brought forward, the en emy will regroup and overrun the audacious platoon's position. On October 24, 1978, President Carter ordered his platoon, the Council on Wage and Price Stability Robert Higgs is Professor of Economics at the Univer sity of washington. He is popular as a lecturer on eco nomic and monetary affairs. His writings include nu merous articles as well as books on The Transformation of the American Economy, 1865-1914, and Competi tion and Coercion.

(COWPS), to attack the advancing wage and price structure of the American economy. Sure enough, a certain amount of market confusion, price distortion, and resource real location ensued. Of course, the Pres ident's diversionary tactic, the "vol untary" wage-price guidelines, did not halt what everyone was calling Public Enemy No.1. In fact, in:fla tion accelerated. After rising 9 per cent in 1978 and 13 percent in 1979, the consumer price index (CPI) zoomed upward at an annual rate of 18 percent during the first quarter of 1980 before subsiding to some what lower double-digit rates. But while they had no effect on acceler ating inflation, the guidelines did have other effects during their first year. They imposed substantial re porting costs on hundreds of large firms; disrupted several important collective bargaining negotiations, twice helping to bring about costly and disruptive strikes; induced dis tortions in the economy's structure of relative prices, with consequent artificial shortages of various goods 643 644 THE FREEMAN November and services and reductions in over all economic efficiency and con sumer welfare; and exacerbated a variety of social conflicts. 2 New Rules, NationalAccord,and Pay Committee In the summer of 1979, the Coun cil began to float its own proposals and to solicit suggestions for changes in the pay and price standards dur ing the second program year, which began on October 1. The consensus was that the standards had to be loosened, as no one seemed willing to retain the original guidelines holding pay increases to 7 percent and price increases to half a per centage point less than the annual rate during 1976-77 -when infla tion was running at 13 percent. Pro posals varied widely. Unhappy with the uniform price deceleration rule, Barry Bosworth, the director of COWPS, wanted to set separate price targets for every industry in the economy. Negative reactions to this sweeping proposal soon led to its abandonment. The Council also pro posed to require firms operating un der the less restrictive profit-margin standard to absorb more of their· un controllable cost increases.

By August it had become appar ent that the new price standard would be little changed. Ultimately the administration settled on the re quirement that firms hold the rate of increase in their average price during the first two program years to no more than during the base pe riod 1976-77. This implied that firms which had complied with the price deceleration standard during the first program .year could raise their prices about one percentage point more during the second program year. The Council also implemented a number of minor changes in the price-re straint rules, including its own pro posal to reduce the amount of un controllable cost increases that firms could pass through to their cus tomers. The greatest difficulties sur rounded proposals for new pay stan dards. Organized labor had opposed the first-year rules and even chal lenged them, unsuccessfully, in the courts. With the presidential elec tion on the horizon, the administra tion longed to placate the union bosses, who openly opposed certain COWPS proposals, such as a two year cumulative pay standard simi lar to the two-year price standard.

Aware of their powerful bargaining position, the union leaders made strong counter-proposals. They wanted to set the wage standard equal to the rate of increase in the CPI plus the long-term rate of in crease in manufacturing labor pro ductivity, which would have blown the lid completely off the pay stan dard. They also proposed the estab lishment of a tripartite board to set, modify, and hear appeals from the 1981 WAGE-PRICE GUIDELINES: RETREAT AND DEFEAT 645 wage standards on an ad hoc basis. As the start of the second program year approached, the union leaders continued to negotiate with Alfred Kahn, the chairman of COWPS, and G. William Miller, the newly ap pointed Secretary of the Treasury. Good Politics Leaders in the administration recognized that the proposed pay board had much to recommend it as a political ploy. Not only would it please the AFL-CIO, but it would also shift the blame for unpopular decisions-indeed for inflation it self-onto the board. Because the board would represent business, la bor, and the "public," its decisions might appear more equitable and hence receive more compliance. The government would be left to play its political games outside the adver sary context inherent where COWPS alone formulated and enforced the rules. While effectively abandoning its attempt to enforce stringent standards, the administration would not have to make an embarrassing disavowal of its previous commit ment to a pay guideline program. In short, the pay board was Good Poli tics.

On September 28,1979, President Carter and the AFL-CIO announced that they had entered into a Na tional Accord. This "historic docu ment" turned out to be a hodgepodge of highfalutin· declarations and vague, mutually incompatible pol icy proposals. While asserting that "the war against inflation must be the top priority of government and of private individuals and institu tions," it maintained that this war "should not mean acceptance of higher than otherwise levels of un employment." The Accord said noth ing specific about the guidelines program except to endorse its con tinuation with "greater public par ticipation." All it really accom plished was expressed in its final paragraph, which declared that "the essence of this National Accord is involvement and cooperation .... It is our purpose to establish proce dures for continuing consultations between American labor leadership and the Administration."3 Besides the AFL-CIO, the Teamsters and the United Auto Workers endorsed the Accord. Thus did the Carter admin istration formally mend its relations with organized labor.

As part of the deal, the President announced the formation of a Price Advisory Committee and a Pay Ad visory Committee. Everyone under stood that the former, a group of six "public" representatives, was a pure formality. The latter, however, was a key concession to the union de mands. It was chaired by John Dun lop, a Harvard economist who had headed President Nixon's Cost of Living Council and served as Secre tary of Labor under President Ford.

646 THE FREEMAN November Besides Dunlop, the Pay Committee included five other "public" mem bers and six each from business and the unions. The Pay Committee moved slowly. Although a second-year pay stan dard was due by October 1, the board took months to resolve its internal conflicts. Labor members wanted the board to invest itself with broad dis cretionary power to validate indi vidual pay agreements on an ad hoc basis. Business members preferred to retain a single numerical pay standard applicable across the board. "Public" members feared that a compromise, which called for pay agreements to fall within a pre scribed range, would effectively es tablish the upper limit of the range as the de facto standard and make a mockery of the compromise. In Jan uary the contentious members fi nally agreed to the compromise, but not until March 14, 1980, did Presi dent Carter publicly endorse the Committee's major proposal. This called for pay increases to be held within a range of 7.5 to 9.5 percent during the second program year. It also established that the value of cost-of-living adjustments (COLAs) would be computed, for purposes of determining compliance, on the as sumption of a 7.5 percent rate of in flation. In practice, these standards were tantamount to no standards at all for labor unions with COLAs in their contracts.

The GuidelinesProgramas an AII around Nuisance Not content with the hundreds of reports received by its small staff during the first program year, COWPS requested even more re ports in 1980. Previously, only com panies with annual sales over $250 million, about 1,200 firms, had to re port. Early in 1980 the Council re quired that all firms with annual sales over $100 million, some 2,900 companies, file quarterly reports. Reporting costs had reached, in the words of a Fortune writer, "untold millions of dollars" during the first year; they must have reached much higher in 1980. A single firm, TRW, Inc., was said to be spending about $1 million per year, mainly for extra employees to handle the extra paper work. This compulsory reporting, required only of large firms, consti tuted an unlegislated new approach to antitrust policy, for it imposed a penalty on bigness per se. The Council's capacity to back up its threats diminished in the second program year. During the first year it had forwarded the names of defi nite noncompliers to the Office of . Federal Procurement, which was authorized by the President to with hold government contracts of $5 million or more. But no one had ever actually been denied a contract, not even the notoriously unrepentant noncomplier, Amerada Hess. The labor unions had strongly objected 1981 WAGE-PRICE GUIDELINES: RETREAT AND DEFEAT 647 to the government's threat to with hold federal contracts-a threat that employers were using as a club in labor negotiations-and precisely this grievance had led them to chal lenge the guidelines in the courts.

As part of the deal that produced the National Accord, the administration made a "gentleman's agreement" not to invoke this sanction against non compliers. Still, the government publicly retained the option to vio late its private gentleman's agree ment. Therefore, the managers of many large firms with substantial government contracts, like Charles R. Allen at TRW, insisted that "the voluntary wage and price guidelines are mandatory for us." Distortions and Inequities So COWPS continued to threaten, negotiate, make deals, and build up its public enemies list of noncom pliers. General Motors, held to have violated the pay standard, agreed to compensate by holding down the prices of its products. Ford, also in violation of the pay standard for its agreement with the United Auto Workers, came into compliance by agreeing to restrain further its pay increases for managerial employees. Chrysler, already foundering in a sea of troubles, was forced to rene gotiate its contract with the UAW.

Yet not everyone would make a deal. By mid-October, 1980, the Council had compiled an enemies .list of 36 companies which had not complied with the guidelines and would not make amends acceptable to the President's men. Wherever COWPS trod in the la bor markets it left a mark of ineq uity. The major source of these dis tortions was the preferential treatment of workers with COLAs the preference arising from the im plausible assumption of 7.5 percent inflation used in evaluating the COLAs. A contract that compen sated workers for two-thirds of the increase in the CPI, for example, could award them a 4.5 percent wage increase outright plus the COLA and still be considered in compliance (4.5 + [2/3][7.5] = 9.5 = the upper limit of the permissible range of pay in crease). If inflation actually turned out to be a mere 12 percent, such a contract increased the workers' compensation by 12.5 percent (4.5 + [2/3][12] = 12.5). Thus, unionized workers with COLAs in their contracts fared much better than other workers. Not only was this directly discriminatory, but it also repre sented a clear encouragement of unionization. Several surveys con firmed that the guidelines distorted wage patterns in many labor mar kets.

4 Personnel managers blamed the pay standards for increased turnover and diminished morale among their employees. COWPS also produced a variety of distortions in the product markets.

648 THE FREEMAN November For example, the aluminum indus try, troubled by guidelines-induced shortages during the first program year, fared no better in the second. An international price disequili brium stimulated a surge of exports, exacerbating the domestic shortage, as the guidelines kept the U. S. price down while foreign prices soared. In February, 1980, American produc ers posted an ingot price of 66 cents per pound, while foreign buyers were paying over 90 cents. When COWPS abruptly changed its rules with re spect to the timing of permissible price changes in March, 1980, pro ducers had to roll back some previ 0usly announced price increases for fabricated products to offset their increased ingot prices. The artificial price juggling dictated for major producers by the erratic guidelines created a cost-price squeeze for smaller companies specializing in extruded aluminum products. Un der the distorted price structure, many of these smaller firms feared that they would soon have to go out of business. Such are the unin tended consequences of twisting the market price structure out of its normal configuration.

Early in 1980, with inflation roar ing along at an unprecedented 18 percent rate, panic set in. A number of vocal economists, including Gar Alperovitz, head of the National Center for Economic Alternatives, Barry Bosworth, erstwhile director ofCOWPS, and Bruce K. MacLaury, president of the Brookings Institu tion, appealed for the implementa tion of comprehensive, mandatory wage-price controls. As always, the general public supported this pro posal. Early in February, the Gallup poll found that 58 percent of those interviewed favored mandatory con trols, only 34 percent opposed them. Most importantly, Senator Edward Kennedy, then vigorously cam paigning against the President for the Democratic nomination, also called for mandatory controls. Diversionary Tactics The President, of course, had to "do something." To his credit, he re sisted the pleas for mandatory con trols. Instead, he pressured a reluc tant Federal Reserve Board into a new diversionary foray, ajerry-built program of controls over credit and investment institutions. And he re sorted to jawboning, launching a se ries of meetings with industry dele gations to urge greater price restraint.

COWPS and the President made good use of public hostility toward the oil industry. On February 25, 1980, the Council released a report accusing eleven oil companies of guideline violations. The Mobil Oil Corporation led the list of sinners. Late in March, Carter publicly ac cused Mobil, which he had earlier called "the most irresponsible com1981 WAGE-PRICE GUIDELINES: RETREAT AND DEFEAT 649 pany in America," of refusing to re fund more than $45 million in al leged overcharges to customers. "It's difficult for me to understand Mo bil's position," said the President, "at a time when compliance is so im portant." Mobil responded that the charges were "patently and ob viously political." The whole dispute turned on a technicality related to whether compliance should be de termined on an annual or a quar terly basis. It sprang originally from Mobil's being caught between con flicting requirements of COWPS and the Department of Energy and was exacerbated by a retroactive change in the rules by COWPS.

In the midst of this furor, the De fense Logistics Agency announced on April! that it had awarded Mobil a $154 million contract for jet fuel. A Pentagon spokesman tried to ac count for this astonishing event by saying that the contract had ac tually been awarded on Friday, be fore Mobil was officially listed as a guidelines noncomplier on the fol lowing Wednesday. But George Marienthal, a deputy assistant sec retary of defense, gave a more plau sible explanation. "The Department of Defense is in the business of na tional security," he said. "We needed the fuel, so we proceeded." (It sub sequently came to light that Mobil and other companies supplying the Department of Defense had been routinely obtaining waivers from CQWPS's standards for a long time.) Still, this little tempest persisted. At a news conference on April 17, Carter again railed against the big oil firm and pledged to "continue to let the American people know about the irresponsibility of Mobil." The company, now taking a more concil iatory tack, maintained that "an honest difference of opinion exists"

and expressed the hope that "this difference can be resolved through good-faith negotiations." Late in April a compromise was finally reached when Mobil agreed to forgo $30 million in permissible price in creases to make amends for the $45 million of alleged overcharges. The government then removed Mobil from its enemies list. In retrospect, the whole affair appears as no more than another sorry episode of Presi dential demagoguery. Assessing the Program's Effectiveness From its beginning, the guide lines program rested on a fallacious economic theory. When one employs this theory in assessing the effec tiveness of the program, one reaches false conclusions. The root of the problem is a persistent confusion of absolute and relative prices. Equiv alently, one can say that the govern ment's theory embraces the lay man's untutored notion that any individual price increase, whether for bread, gasoline, or labor, signi650 THE FREEMAN November fies inflation. Defining inflation in this way, which is now common place in the news media-witness "energy inflation," "wage inflation,"

and similar terms-can only con fuse and mislead. Proponents of this view quickly arrive at the conclu sion that prices (in general) rise be cause prices (in particular) rise. This attempt to substitute arithmetical identity for economic theory is com pletely empty as an explanation of inflation. 5 In modern economic analysis, in flation is defined as an ongoing de cline in the purchasing power of money. Inflation, properly defined, cannot occur unless total money ex penditure increases relative to total real output. In recent years, infla tion has occurred mainly because large increases in the money stock have fueled a rapid increase in money expenditure while total real output was expanding much more slowly or sometimes not at all. The Federal Reserve System, under heavy pres sure to monetize the enormous fed eral deficits-not OPEC and not acts of God-caused this excessive growth of money expenditure.

Yet the government continued to deny all responsibility and to at tempt to shift the blame onto others Big Business, Big Labor, Arabs, and Nature. In his economic report to the Congress in January, 1980, President Carter's third sen tence was: "Higher oil prices were the major reason for the worldwide speedup in inflation during 1979." Inflation was "concentrated in a few areas," he said, citing energy, home ownership and finance, and food. This is nonsense. Inflation cannot be "concentrated" in certain product lines; it is not something that hap pens to the prices of particular products but rather applies only to the average price of all products (or, equivalently, to the single "price" of money). Self-Satisfaction The guidelines, according to the President, "served the Nation well. Although the price standards had only limited applicability to food, energy, and housing prices, in the remaining sectors of the economy, for which the standards were de signed, prices accelerated little." This assessment rested on the findings of studies by the Council of Economic Advisers as well as COWPS. The latter Council concluded from its statistical analyses that "had the standards not been in place during the year and a half ending in March 1980, the annual rate of increase of labor compensation would have been almost 2 percentage points higher ... and the overall inflation rate al most 1/2 to 3/4 percentage points higher."6 This conclusion only reflected the idea that inflation occurs whenever an individual product price rises.

1981 WAGE-PRICE GUIDELINES: RETREAT AND DEFEAT 651 During the year and a half studied, the GNP deflator, an index of the overall average price level, in creased at an annual rate of about 9 percent. (The CPI, an unrepresen tative index of the overall price level, increased during the same period at an annual rate of about 16 percent.) The Council claims that because some prices, those effectively restrained by the guidelines, rose less than they otherwise would have, the overall rate of inflation was restrained. This assertion implies, first, that the rate of increase of money expenditure di minished for one class of goods (those subject to the guidelines, which rep resent about 60 percent of the econ omy), which is by no means certain, inasmuch as enough additional units could have been bought to more than compensate for the restrained prices; and, second, that the rate of increase of money expenditure for all other goods remained the same as it would have been in the absence of the guidelines, which is implausible.

Neither COWPS nor the 'CEA at tempted to show that the guidelines reduced the rate of growth of overall money expenditure. Of course, they could not show this, because it did not happen. To the extent that the guidelines succeeded in restraining some indi vidual prices-and they certainly appear to have done so-they suc ceeded only in distorting the struc ture of relative prices, not in reducing inflation. Inflation, no matter which index is used as a measure, unquestionably accelerated after the guidelines program went into effect. The GNP deflator increased at an annual rate of 6.9 percent between the third quarter of 1976 and the third quarter of 1978. Between the latter quarter and the second quar ter of 1980, under the guidelines, the annual rate of increase was 9.2 percent-exactly one-third higher. The guidelines clearly failed to pre vent an acceleration of inflation. 7 To show that they simultaneously dis torted the relative price structure, as COWPS and the CEA proudly did without fully appreciating what they were doing, is only to add another item to the already lengthy indict ment against this make-believe anti inflation program. In reality, be cause distortion of the relative price structure leads to misallocation of resources, thereby increasing eco nomic inefficiency, one can conclude that the guidelines must have raised the rate of inflation by lowering the economy's total real output below what it otherwise would have been.

The End As the summer of 1980 merged into autumn, I the coming elections preoccupied the Carter administra tion, and the guidelines program re ceived little attention. The two ad visory committees recommended that the existing standards be extended 652 THE FREEMAN through December 31, and COWPS accepted this recommendation. The guidelines, said Kahn, were a "pro foundly political" subject, and it would be best to defer consideration of further changes in the program until after the election. Most of the suggestions received from business and the general public called for ei ther retaining the existing stan dards or scrapping the program al together. In August the Business Roundtable, a group of some 200 ex ecutives of major corporations, which had earlier supported the program, called for its termination. Guide lines, said the Roundtable, "distort public understanding of the causes of inflation." True enough, but un fortunately the program had done much greater damage. Most signifi cantly, it had helped to delay the ul timate day of reckoning when the inflationary enemy must be faced squarely and fought with real weap ons. It had therefore insured that the inevitable battle would be an even costlier and more socially wrenching affair.

With Jimmy Carter's crushing de feat on November 4, 1980, the guidelines were doomed to pass away completely. But we would do well to remember that this kind of policy, like the phoenix, has a way of rising from the ashes. (Not so long ago, a Republican administration, on frightfully flimsy grounds, gave us mandatory wage-price controls.) Inflation is not about to disappear sim ply because Ronald Reagan has been elected. To bring it under control, heavy economic and social costs will have to be borne and difficult politi cal decisions made. Not inconceiv ably, the Reagan administration may someday find itself tempted to im pose controls. One can only hope that a full appreciation of the workings of the Carter program-and of the Nixon program before it-will dis courage any future resort to such misguided and counterproductive policies. ® -FOOTNOTESIGeorge P. Shultz and Kenneth W. Dam, "The Life Cycle of Wage and Price Controls," in Eco nomic Policy Beyond the Headlines (New York: Norton, 1977), pp. 65-85.

2Robert Higgs, "Carter's Wage-Price Guide lines: A Review of the First Year," Policy Re view 11 (Winter 1980):97-113. 3AFL-CIO, The National Economy, 1979 (Washington, D. C., November 1979), n.p. 4Paul Bennett and Ellen Greene 1 "Effective ness of the First-year Pay and Price Stan dards," Federal Reserve Bank of New York Quarterly Review (Winter 1979-80):52-53. 5Robert Higgs, "Blaming the Victims: The Government's Theory ofInflation," Freeman 29 (July 1979):397-404. 6Council on Wage and Price Stability, "The Pay/Price Standards Program; Evaluation and Third-Year Issues," Federal Register 45 (Fri day, July 11, 1980):47067. See also the Annual Report of the Council of Economic Advisers (Washington, D. C., 1980), pp. 38, 84. 7Jon Frye and Robert J. Gordon, "Govern ment Intervention in the Inflation Process: The Econometrics of 'Self-Inflicted Wounds,'" American Economic Review 71 (May 1981):292.